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Unformatted text preview: MC D AC Quantity (washers) H G MR D H G P 600 C Z $/washer 600 40 N 1 Number of models P = Price UC UC 1 K R P 1 P 1 Q Q 1 MR MR 1 MC D D 1 AC Quantity (washers) H H 1 G G 1 Chapter 3 Why Everybody Trades: Comparative Advantage 2. Agree. Imports permit the country to consume more (or do more capital investment using imported capital goods). Anything that is exported is not available for domestic consumption (or capital investment). Although this loss is bad, exports are like a necessary evil because exports are how the country pays for the imports that it wants. 4. If the countries trade with each other at the relative price of 1 W/C, then shifting only half way to complete specialization in production would be worse for each country than shifting to complete specialization. If the United States shifted only half way, then its new trade line would be parallel to the trade line shown in Figure 3.1, and it would start from the point on the ppc that is half way between S and S 1 . While this new trade line would allow the United States to consume at a point that had more consumption than at the initial S , the United States could do even better by shifting production all the way to points S 1 and consuming along the trade line shown in Figure 3.1. Consuming at a point like C would have even more consumption than consuming at a point on the new half-way trade line. Essentially the same reasoning can be used for the rest of the world, for a new trade line that is parallel to the rest of the worlds trade line shown in Figure 3.1, but that begins at a point on the rest of the worlds ppc that is half way between S and S 1 . 6. Using the information on the number of labor hours to make a unit of each product in each country, you can determine the relative price of cloth in each country with no trade. With no trade, the relative price of cloth is 2 W/C (= 4/2) in the United States, and it is 0.4 W/C (= 1/2.5) in the rest of the world. With free trade the equilibrium world price of cloth must be in the range bounded by these two no-trade prices. So, yes, it is possible that the free-trade equilibrium relative price of cloth is 1.5 W/C (1.5 is greater than 0.4, and less than 2). 8. a. Moonited Republic has an absolute advantage in wineit takes fewer labor hours to produce a bottle (10<15). Moonited Republic also has an absolute advantage in producing cheeseit takes fewer labor hours to produce a kilo (4<10). b. Moonited Republic has a comparative advantage in cheese. The opportunity cost of producing a kilogram of cheese is 0.4 (= 4/10) bottles of wine in Moonited Republic, while the opportunity of a kilo of cheese in Vintland is 0.67 (= 10/15) bottles. Vintland has a comparative advantage in wine. The opportunity cost of a bottle of wine is 1.5 kilos of cheese in Vintland, while it is 2.5 kilos in Moonited Republic....
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- Spring '08